QSBS Basis and Holding Period: Calculating Basis and Meeting Holding Requirements

Understanding how basis and holding period are determined for Qualified Small Business Stock (QSBS) is critical for calculating exclusions, applying per-issuer limits, and ensuring compliance with holding period requirements. This page explains the basis and holding period rules applicable to QSBS.

Basis Rules for QSBS

General Basis Rules Apply

General tax basis rules apply to QSBS, with some special provisions under Section 1202(i).

Stock Exchanged for Property

If a taxpayer transfers property (other than money or stock) to a corporation in exchange for stock:

• The stock is treated as acquired on the date of the exchange [IRC §1202(i)(1)(A)]
• The basis of the stock in the hands of the taxpayer shall in no event be less than the fair market value of the property exchanged [IRC §1202(i)(1)(B)]

This prevents basis from being less than fair market value for Section 1202 purposes.

Contributions to Capital

If the adjusted basis of QSBS is adjusted by reason of any contribution to capital after the date of original issuance, the basis of the contributed property shall in no event be treated as less than its fair market value on the date of contribution. [IRC §1202(i)(2)]

Note: For purposes of the per-issuer limitation calculation, adjusted basis is determined without regard to any addition to basis after the date on which such stock was originally issued. [IRC §1202(b)(1)]

This means that while contributions to capital increase basis generally, they do not increase the "10 times basis" alternative limit calculation.

Holding Period Rules

General Rule: Section 1223 Applies

Section 1223 provides general rules for determining holding periods. These rules generally apply to QSBS, subject to special rules discussed below.

Holding Period for Original Issue Stock

For stock acquired at original issue in exchange for cash or property, the holding period generally begins on the day after acquisition.

Example: Stock purchased on January 1, 2020, has a holding period beginning January 2, 2020.

Holding Period for Stock Received for Services

For stock received as compensation for services, the holding period begins on the date the stock is substantially vested (generally, when it's no longer subject to a substantial risk of forfeiture).

Section 1223 Tacking Rules

Section 1223 allows holding periods to "tack" (continue) in certain circumstances:

• Gifts: Donee's holding period includes donor's holding period [IRC §1223(2)]
• Transfers at Death: Heir's holding period includes decedent's holding period [IRC §1223(11)]
• Tax-free Exchanges: In certain tax-free exchanges, the holding period of the property received includes the holding period of the property exchanged

Section 1202 Holding Period Rules

Transfers by Gift and Death

Section 1202(h) provides that for transfers by gift, transfers at death, and certain partnership distributions, the transferee is treated as having held the stock during the continuous period it was held by the transferor. [IRC §1202(h)(1)]

Key Point: The holding period includes the transferor's holding period, allowing beneficiaries and donees to satisfy holding period requirements even if they didn't hold the stock for the full period themselves.

Section 351 Exchanges and Reorganizations

For stock acquired in Section 351 exchanges and certain reorganizations, Section 1202(h)(4) provides that the new stock is treated as qualified small business stock acquired on the date the exchanged stock was acquired. [IRC §1202(h)(4)(A)]

This means the holding period of the exchanged stock is included in the holding period of the new stock for Section 1202 purposes.

Conversion of Other Stock

If stock is acquired solely through the conversion of other stock in the same corporation which is QSBS, the converted stock is treated as QSBS and is treated as having been held during the period the original stock was held. [IRC §1202(f)]

Example: Preferred stock converts to common stock. The common stock is treated as QSBS if the preferred was QSBS, and the holding period includes the period the preferred was held.

Section 1045 Holding Period Rules

Section 1045(b)(4) provides special holding period rules for rollover purposes:

No Tacking for Section 1045

For purposes of determining whether Section 1045 rollover applies:

• The taxpayer's holding period for the original stock and replacement stock is determined without regard to Section 1223 [IRC §1045(b)(4)(A)]

This means holding periods do not tack for Section 1045 rollover purposes.

Only First 6 Months Count for Active Business Test

Only the first 6 months of the taxpayer's holding period for the original stock is taken into account for purposes of applying Section 1202(c)(2) (the active business requirement) to the replacement stock. [IRC §1045(b)(4)(B)]

This means the replacement stock must independently satisfy the active business requirement, with only 6 months of credit from the original stock's holding period.

Partnership Holding Period Rules

Pass-Through Treatment

Under Section 1202(g), when QSBS is held by a partnership, the partner's holding period for Section 1202 purposes is determined at the partnership level—the partnership must have held the QSBS for the required period. [IRC §1202(g)(2)(A)]

The partner must have held an interest in the partnership from the time the partnership acquired the QSBS through disposition. [IRC §1202(g)(2)(B)]

Distribution from Partnership

When a partnership distributes QSBS to a partner, the partner is treated as having held the stock during the continuous period it was held by the partnership. [Reg. 1.1045-1(e)(1)]

Calculation of Holding Period

Days vs. Years

For holding period purposes:

• "More than 5 years" means at least 5 years and 1 day
• "At least 3 years" means 3 years or more

Example: Stock acquired on January 1, 2020, is held for "more than 5 years" if sold on or after January 2, 2025.

Fractional Years

Holding periods are generally calculated by counting full periods. Partial years count toward the holding period.

Basis and Per-Issuer Limits

10 Times Basis Calculation

For purposes of the per-issuer limitation, the limit is the greater of:

• The dollar amount ($10 million or $15 million), or
• 10 times the aggregate adjusted bases of QSBS disposed of

Important: For this calculation, adjusted basis is determined without regard to any addition to basis after the date on which such stock was originally issued. [IRC §1202(b)(1)]

This means:

• Original basis counts
• Contributions to capital that increase basis after original issuance do not count for the 10-times-basis calculation (though they count for general basis purposes)

Key Takeaways

1. General basis rules apply: Standard basis rules apply to QSBS, with some special provisions

2. Basis cannot be less than FMV: For property exchanges, basis cannot be less than fair market value of property exchanged

3. Holding period generally tacks: For gifts, death, and certain exchanges, holding periods include the transferor's period

4. Section 1045 has special rules: No tacking for Section 1045 rollover purposes

5. Partnership rules are entity-level: Partnership must hold QSBS for the required period

6. "More than 5 years" means 5+ days: Must hold at least 5 years and 1 day for pre-applicable date stock

7. Basis for limits excludes post-issuance additions: Contributions to capital after original issuance don't count for 10-times-basis calculation

Sources and Citations

• IRC Section 1202(i): Basis rules
• IRC Section 1202(h): Transfers that preserve QSBS status and holding periods
• IRC Section 1202(f): Conversion of stock
• IRC Section 1223: General holding period rules
• IRC Section 1045(b)(4): Special holding period rules for rollovers
• IRC Section 1202(b)(1): Basis determination for per-issuer limits

Verification Date: January 2025

Note: This page reflects the law as of January 2025. Basis and holding period rules are complex and fact-specific. This information should not be construed as legal or tax advice. Consult with qualified tax counsel regarding basis and holding period determinations for your specific situation.